Four charts that explain the 2014 market so far

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Published: Jan 7, 2014 12:08 p.m. ET

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As new-year pension money pours in, the stock market is screaming higher today. The true test will be when the very short-term oversold condition is relieved. In spite of today’s rally, the first three days have a major significance that investors should pay attention to.

On the first day of 2014, the stock market fell; this was the first such occurrence after six years.

On Monday, the DJIA traced an outside day. In the present context, an outside day — which is formed when the high of the day is higher than the high of the previous day and the low of the day is lower than the low of the previous day — is considered negative in traditional technical analysis.

In the statistical analysis done at The Arora Report, contrary to common belief, outside days by themselves are not very significant; however, they often foretell the future if they occur after a prolonged advance, and the high of the day occurs at or near the open and the close is at or near the close of the day. The DJIA met all of these three criteria yesterday. Take a look at the chart of SPDR Dow Jones Industrial Average ETF Trust
DIA, -0.29%
which represents DJIA.

The market internals are now again similar to the beginning of December 2013 and September 2011. In September 2011, the market experienced about a 7% correction. In December 2013, the market reversed and moved upward.

The Nasdaq 100 has fallen three days in a row, as you can see on this chart of the PowerShares QQQ Trust Series 1 ETF
QQQ, -0.03%
which represents Nasdaq 100.

The first three days for the QQQ in January 2014 resembles the first three days of DIA in December 2013. A proper analysis takes into account many more factors than just the charts. In the beginning of December, when many market technicians thought that the pattern from the first three days was projecting a lower market, I wrote on MarketWatch . My December call proved spot on.

The market always has push and pull from hundreds of different factors. In my December column, I described some of the factors other than the technical pattern and concluded that these other factors would overcome the negative technical pattern. The question today is, "Are there other factors now that will overcome the technical patterns?"

Let me show you two charts, one of them is positive for the market and the other one is negative for the market.

One of the many factors we use at The Arora Report in our timing model is to see how key stocks behave at their support and resistance levels. For this purpose, we have constructed a basket of 100 stocks, and we analyze them individually. Apple
AAPL, -0.11%
is one of the stocks in the basket.

On Monday, Apple fell to approach the top of the support zone and then bounced back strongly.

We determine support zones based on the money inflows and money outflows into a stock as calculated from tick data. Many market participants use the 50-day simple moving average (SMA) to determine the support level. As shown on the chart, the stock briefly dipped below the 50-day SMA and then bounced back strongly.

There is no sound intellectual basis to use a 50-day SMA as support. Why do many investors use the 50-day SMA as support? The answer lies in the history. About 100 years ago, there were no computers, and the availability of real-time data was scarce. Under the circumstances, ingenious traders came up with SMA, which was easy to calculate by hand and was considered a cutting edge technique in the days gone by. Even though the world has changed, many still cling to old traditions. The 50-day SMA derives its power simply because many believe in it and act on it.

The foregoing discussion is important because we are observing action similar to Apple in about three-quarters of the stocks in our basket. This is a positive for the market.

Now let us look at another chart that is negative for the market. The chart compares SPDR S&P 500 ETF Trust
SPY, -0.20%
to the SPDR Gold Trust ETF
GLD, +0.86%
and the iShares Silver Trust ETF
SLV, +1.23%

In late December, we started accumulating three gold and gold miner closed-end funds. The dominant weight in our model was given to a simple observation that at the beginning of the year, tax-loss selling overhand would lift, and gold would bounce. This is exactly what has happened as shown on the chart. One reason that gold had been going down is because the stock market was going up. Investors were simply selling gold and putting money into stocks. Interestingly, the chart shows that in the last three days, gold has outperformed stocks by about 2%. Gold outperforming stocks is a negative signal for stocks.

An additional powerful observation can be made from the chart. Silver is lagging gold by about 50%. In general, silver leads gold, typically by about 100% in similar circumstances. When silver lags gold as much as it is now, it means that speculative juices among investors are very weak. Historical data shows that this is another negative indicator for stocks.

The foregoing are only a small fraction of the considerations that investors should think about. Our timing model, which takes into account the foregoing and many other factors, is showing mixed results at this time. Note that this is the same model that was telling us with conviction in the beginning of December, when the market went down for three days, that there was not much to worry about.

Disclosure: Subscribers to The Arora Report have positions in AAPL, SPY, and funds that are related to gold and silver.

Intraday Data provided by SIX Financial Information and subject to terms of use. Historical and current end-of-day data provided by SIX Financial Information. All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only. Intraday data delayed at least 15 minutes or per exchange requirements.